Can a simplified repayment process strengthen student financial outcomes?
The problems around college affordability and student debt in the U.S. are well-documented: federal student loan debt is approaching $1.5 trillion, and about 1 of every 5 American adults have student loan debt. Many of today’s students do reach the milestone of earning their college degree, but then must overcome the hurdle of successfully repaying their federal student loans.
Since 1994, the federal government has offered income-driven repayment (IDR) plans to help borrowers with lower earning power repay their federal student loans at a slower pace without penalty. Income-driven repayment plans are a series of federal programs that allows borrowers to repay their loans based on their income, family size, and loan balance. Over 7 million borrowers are enrolled in IDR plans; the percentage of borrowers enrolled in IDR plans increased from 13 percent in 2014 to 28 percent in 2017. Even though more borrowers are enrolling in IDR, the program can still be improved to better serve today’s students.
The Promise of Income-Driven Repayment
Income-driven repayment is beneficial to both borrowers and taxpayers. In the terms and conditions of the IDR program, the federal government made a commitment to student loan borrowers to offer affordable repayment options. Policymakers understood that many borrowers could not afford to repay their loans in ten years, and had periods of lower and uncertain income. Income-driven repayment provides borrowers the option to extend their years of repayment and tailor borrowers monthly payment to their income without undue financial hardship while remaining in good standing on their loan.
Challenges with Income-Driven Repayment
The Number of Plans
Despite good intentions, income-driven repayment can be overwhelming and confusing for today’s students with outstanding federal student loans because there are six IDR plans on the books, each with their own eligibility requirements. Our IDR 101 outlines the different plans available and their respective eligibility requirements. Policymakers have considered and continue to raise the idea of reducing the number of income-driven repayment plans available to borrowers, as simplification would make the repayment process less confusing.
A process called “recertification” poses another barrier to borrowers looking to streamline and reduce their student loan payments. IDR plans require borrowers to recertify their income annually in order to continue to remain on their plan. However, 57 percent of borrowers fail to recertify their income on-time, and about 18 percent of borrowers who missed their recertification date were put into a hardship-related forbearance or deferment. Depending on the type of loan, a borrower may be responsible for paying the accrued interest during a hardship-related forbearance or deferment. The interest accrued during this period will be capitalized; therefore, increasing the borrowers student loan balance. Only about eight percent of borrowers successfully recertified their income one month after the deadline, demonstrating that annual recertification may prevent some borrowers from successfully repaying their federal student loans.
Borrowers who fail to recertify their income may be placed into standard repayment if they fail to recertify their income on time. The standard repayment plan requires borrowers to make monthly payments based on what it would take to pay the loan off in 10 years. This switch could result in a significantly higher monthly payment for borrowers.
Taxing Loan Forgiveness
After a borrower has made payments under their IDR plan for 20 or 25 years (depending on the plan), the remaining student loan debt is forgiven, but also taxed, which can be detrimental to low-income and middle class individuals. Given the length of time that may occur between when a borrower enters repayment and receives forgiveness, a borrower may be unaware of the tax bill that comes their way once the remainder of their loan has been forgiven after 20 or 25 years, and may face hardship when paying this tax bill.
Improving Income-Driven Repayment: Various Proposals
With growing calls to improve and simplify income-driven repayment, policymakers have put forward proposals to combat some of the challenges borrowers face in IDR:
In his Fiscal Year 2018 Budget request to Congress, President Trump proposed to reform IDR plans by creating a single plan that would cap a student’s monthly loan payments at 12.5 percent of discretionary income, and eliminate loan forgiveness entirely.
Last December, House Education and Workforce Committee Chairwoman Virginia Foxx (R-NC) introduced the PROSPER Act, which offers one income-based repayment program where the monthly payment amount is equal to 15 percent of the borrowers’ discretionary income. Under the program, except in situations where graduates pay off the loan early, the total amount a borrower could be expected to pay would be limited to what the borrower would have paid on a 10-year fixed payment plan, plus interest.
In July 2018, House Democrats on the Committee on Education and the Workforce also proposed changes to income-based repayment program when they introduced the Aim Higher Act. This proposal offers uncapped monthly payments at 10 percent of discretionary income, no financial hardship requirement and loan forgiveness after 20 years. The plan also states accrued interest over the lifetime of the loan cannot exceed 50 percent of the principal borrowed, and borrowers making under 250 percent of the federal poverty line will have $0 payment.
Bipartisan Senate Bill
The bipartisan SIMPLE Act, introduced in 2015-2016 and again in 2017-2018 by Rep. Bonamici [D-OR], Rep. Costello [R-PA], and Sen. Wyden [D-OR] would allow for automatic recertification of borrowers’ incomes while they are enrolled in income-driven repayment plans and automatically enrolls severely delinquent borrowers in income-driven repayment.
What’s Next for IDR?
As policymakers work towards the goal of increasing college completion and strengthening the workforce and economy, the income-driven repayment process is a critical tool for reducing student loan balances and default. There is growing recognition that income-driven repayment is essential to helping borrowers repay their federal student loans. Now, policymakers can make the process more seamless and effective for borrowers by eliminating the tax on loan forgiveness, creating a more streamlined recertification process, and gradually simplifying the number of IDR plans to one by “sunsetting” the old plans once borrowers have completed the terms and conditions.